Over the previous 18 months, equities have undeniably been the star performer of all asset classes. Since the United States’ Federal Reserve initiated its open-ended quantitative easing program in September 2012, the DJIA and the S&P 500 have each returned over 25% on invested funds. Equities have without a doubt been the benefactor of ‘cheap money’ as the FOMC sought to artificially depress yields on fixed income securities.
In retrospect, the QE3 program has arguably been a runaway success. The then Fed Governor, Ben Bernanke, has been credited with helping stave off a further prolonged recession, mitigating the threat of disinflation and - most importantly - tackled spiraling unemployment. With stock markets now testing all-time highs, the underlying debate throughout investor circles is to ask, where do we go from here?
Amongst traders and fund managers alike, the conventional method of attaining exposure to the overall stock market in a cost-efficient way is through the utilisation of index trading. Ensuing is a concise analysis of three of the most actively traded indices along with the macro-economic, country distinct and constituent specific factors affecting each of the benchmarks.
Dow Jones Industrial Average
Despite the inclusion of the word ‘industrial’, the Dow as it is commonly referred to as a ‘price-weighted’ index comprising of thirty bellwether companies from across multiple sectors of the U.S. economy. The benchmark index has recently borne the brunt of considerable short-term selling pressure as a result of downside momentum from the biotechnology and technology sectors spilling over into the consumer discretionary and financial stocks.
Recent capital appreciation of a number of stocks has countered accepted valuation methodology with higher than normal P/E ratios, leading many to believe the present market hubris is an indication to begin booking profits.
A further hurdle to upside potential on the Dow has been the array of weaker than anticipated economic data from both the U.S. and China. Employment figures released within the U.S. and GDP data from China has led to increased volatility and historically broad-based sell-offs as investors priced-in a less optimistic outlook.
Geopolitical tensions surrounding the crisis in Ukraine have also led to an uptick in volatility within integral commodity markets such as natural gas and crude oil. The hardening rhetoric and retaliatory moves from Russia in response to increasing sanctions from the U.S. have prompted a capital flight away from equities and into safe-haven assets such as Gold and the Japanese Yen. Despite the probability of NATO military intervention being close to zero, the animosity has unsurprisingly led to additional uncertainty which continues to drag sentiments lower.
Early May saw the Dow attempt to surpass the all-time high of 16,736 however, the market failed to hold onto this level. Owing to the nature of trading in unknown territory, traders relying on technical analysis have found little information to work with. It is reasonable to assume that the benchmark will face a psychological resistance level at 17,000 which will require a bullish change in the fundamentals if this point is to be breached.
Medium-term support has been witnessed around the 16,000 and 15,700 levels however less emphasis should be placed on these points as the Dow is presently a fundamentals driven market.
The DOW has performed well of late. However, it is a typically volatile market as global political and industrial events will have an inevitable effect on the index. When trading the DOW Jones 30 you can benefit from a tighter spread when trading with Spread Co. With Spread Betting our spread is just 0.8; meaning the market needs to move less before you start making a profit. You can even place short positions and take advantage of downturns in the index.
To find out more about trading the DOW Jones 30 with Spread Co, click here.
The FTSE 100 is the most widely observed index in the United Kingdom. Comprised of leading stocks encompassing all sectors of the economy, the market has rallied off the back of strong growth figures and falling unemployment data. In defiance of the old adage of not shorting new highs, investors have been engaging in staggered profit taking by settling long positions and thereby increasing downside momentum.
Historically the FTSE 100 has followed a positive correlation with the DJIA and the MSCI World Index. Therefore factors discussed previously, affecting stocks across the Atlantic, have an indirect effect on the direction of the FTSE. Ukrainian tensions continue to hang over investor sentiment and the additional volatility is prompting asset managers to allocate a greater portfolio weight to cash.
An additional obstacle to reaching new highs has arisen in the form of a strong Sterling rate. GBP/USD has hovered close to five-year highs at 1.69 thereby making it more expensive for foreign investors to buy Sterling denominated assets.
Having last traded as high as 6,950 in 1999, the FTSE 100 is currently trading within a defined range only 1.2 - 1.5% lower. A short-term resistance level has appeared around the 6,885 level as profit taking on long positions has prevented the benchmark index from reattempting an ascent back to the psychological resistance level of 7,000.
The relative value of Sterling continues to be of significance, especially to overseas investors, and it is worth noting that the two markets have followed a positive correlation of returns with both markets trading close to new highs. The GBP/USD cross touched an all-time high of 1.6996 at the beginning of May; however, it has since pulled back following the BoE move to dampen expectations of an impending rate hike.
With the UK economy beginning to show signs of renewed strength the FTSE has reflected these economic improvements hitting record highs. However, the UK index is inexorably linked to the DJIA. As a result it is still prone to the volatility of the US index. Spread Co’s tight fixed spreads mean that, even in times of volatility, you can benefit from reduced trading costs.
The German economy is Europe’s largest and arguably most resilient, with a robust manufacturing
sector and rising current account surplus. Investor appetite for Peripheral Eurozone Government bonds - including Portugal, Italy, Ireland, Greece and Spain - has depressed yields on German Bunds and led to a capital inflow to domestic equity markets.
The ECB, in an attempt to counter prospective deflation, is poised to further cut the overnight deposit rate, possibly into negative territory. Such an unprecedented move should benefit
European equities whilst also devaluing the Euro, which has recently risen versus the U.S. Dollar. Thomson Reuters has reported a pickup in pan-European M&A activity, a sign of flourishing economic activity on the continent.
Traders holding positions in the Dax or any of its constituents continue to have a vested interest in the geopolitical tensions which Europe has become embroiled in. Sanctions imposed upon Russia and the anti-business rhetoric coming from both sides is having the effect of decelerating upward momentum.
Much like its U.S. counterpart, the Dax appears to be being directed by changes in fundamentals as opposed to technical levels. Like the Dow, the Dax is close to all-time highs and therefore technical analysts have little historic data upon which to base predictions. The Dax has traded sideways for much of May, trading approximately 1.5% lower than its all-time high of 9795.2 seen in January of this year.
Medium term support is evident at the 9,050 level however, a move below this point could see a rapid descent down to around 8,550. With the short-term direction being wholly dictated by fundamentals, the chart does indicate that the medium and longer term trends are bullish.
The German economy has gone from strength to strength in recent years and is considered to be one of the most robust in Europe. Unfortunately, being such a European powerhouse, the Dax can be affected by a fall in surrounding countries’ economies and geopolitical tensions – regardless of the country’s perceived individual strength. Spread Co offers a 1 point fixed spread on GERMANY 30 (Dax 30), an increasingly popular market and, having recently achieved all-time highs, data for the future movement of the Dax is limited. Therefore, the potential highs the market could reach are somewhat a mystery.
Upon assessment of the global equity markets, it is apparent that investors have priced in the expectation of continuing gradual ‘tapering’ of FOMC operations. Uncertainty does yet remain as a result of geopolitical tensions in Ukraine, Chinese GDP concerns and potential Eurozone deflation. Economic data and unanticipated developments have had (and will continue to have) a material and immediate impact on the direction of the equity market over the near-term.
Looking ahead to the medium and longer-term, asset managers are likely to continue rotating away from fixed income securities and into perceived riskier asset classes, such as equities. Major investment banks have upped their 2015 year-end forecasts, despite the prevailing uncertainty discussed previously. Potential upside remains as the argument for persevering with loose monetary policy continues to be in favour. Central bankers are having to contend with stubbornly low inflation, which remains prevalent, and, notable slack in the labour market, despite the falling unemployment rate.
Any retracement away from fresh highs will conceivably be a short-term correction and will be unlikely to reverse the current bullish uptrend. A contrarian approach is potentially profitable in the short-term. Nonetheless it is assuredly a high risk strategy. Overall, the consensus is that equity markets will print further highs prior to December 2014.The debate remains on whether this might occur remains and, if it does, how much further into this unchartered territory will the market go.
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The Spread Co Team
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Spread Co is an execution only service provider. The material on this page is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by Spread Co Ltd or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.
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